question archive When a business considers investing in a new project, the decision must be carefully evaluated
Subject:ManagementPrice: Bought3
When a business considers investing in a new project, the decision must be carefully evaluated.
Businesses should invest in projects that are expected to add value to the company. One
method to determine the added value of a project is net present value (NPV) analysis. NVP
analysis determines the present value of the benefits and costs of a project. If the project’s NPV
is greater than $0, then the project is considered to add value to the company. For this
discussion, you will practice calculating the added value of project using the NPV.
Prepare:
Prior to beginning work on this discussion forum,
• Complete the Week 4 – Learning Activity 1.
• Read Chapter 7 of Essentials of finance.
For the initial post, you will complete the NPV problem below. You will not be able to see other
students’ posts until you post your initial post.
Problem:
A large auto company has just completed the research and development (R&D) on a new
product, the Electrobicycle. The Electrobicycle is an electronic, climate-controlled bicycle with
zero emissions. The R&D efforts focused on developing the capability to utilize electricity to
power bicycles. Ultimately, the auto company expects Electrobicycles to be popular for most
urban citizens due to convenience and low cost.
The R&D, which cost $3 million, is complete and paid for. The plant and equipment to mass
produce the Electrobicycles will cost $2 million. This plant and equipment will be depreciated
over 5 years using the straight-line method to zero book value ($400,000 per year). A working
capital investment of $1 million will be needed at the beginning of the project. A working
capital investment of $200,000 per year will be needed thereafter.
At the end of 5 years, the auto company believes there will be no more sales opportunities for
Electrobicycles and will cease all production. Thus, at the end of the project, all working capital
investments (the $1 million initial investment and the $200,000 per year) will be recovered at
full value. The plant and equipment will be scrapped for a salvage value of $300,000 (after tax).
The company expects moderate sales in years 1 and 2, and then significant growth in each year
thereafter as consumers adopt the Electrobicycles. Revenues and earnings will cease at the end
of Year 5. The revenues, after-tax earnings, and cash flow for the 5-year life of the project are
shown in this table.
Table 1
https://ashford.instructure.com/courses/102748/assignments/2004689
Projected Electrobicycle Financial Projection
Numbers in $000’s
Today Year 1 Year 2 Year 3 Year 4 Year 5
Revenues $1,000 $1,500 $3,000 $6,000 $12,000 After-tax earnings
($500) $100 $300 $600 $1,200
Project Cash
Flow
After-tax earnings
($500) $100 $300 $600 $1,200
Plus: Depreciation
$400 $400 $400 $400 $400
Less: Cost of plant, equipment
($2,000) $0 $0 $0 $0 $0
Less: Working capital
($1,000) ($200) ($200) ($200) ($200) ($200)
Plus: Recovery of working capital
n/a n/a n/a n/a $2,000
Plus: Salvage value
n/a n/a n/a n/a $600
Annual project cash flow
($300) $300 $500 $800 $4,000
Note: n/a = not applicable
Calculate:
• Determine the NPV for the Electrobicycle project. Use the annual project cash flow from
the table above. For the required rate of return, use the percent value from your
birthday date. For example, if your birthday falls on the 16th of the month, the required
rate of return would be 16%.
o For guidance, review Section 7.1 of the textbook, NPV Example: The Pizza
Scooter Delivery Project Revisited.
Write:
In your post, include the following:
• Calculate the NPV of the Electrobicycle project. Be sure to show your NPV calculations.
• Explain, in your own words, why working capital investments are subtracted each year
in the cash flows.
• Explain, in your own words, the meaning of the required rate of return for the project.
• Assume the auto company has a required rate of return of 15%. Based on the required
rate of return you used for the Electrobicycles (based on your birthday date), is the
Electrobicycle project more or less risky than the auto company? Explain your answer.
• Based on your concluded NPV, should the company invest in this project to build
Electrobicycles? Justify your answer.
Guided Response: Review several of your colleagues’ posts, and reply to at least two of your
peers by 11:59 p.m. on Day 7 of the week. You must respond to two classmates who have
completed different calculations than you. In your written responses to your classmates,
address the following:
• Confirm the calculations or explain a correction to the calculation in the initial post.
• Compare how the required rate of return you used differs from your classmate’s rate of
return.
• Explain how the different rate of returns impacted the concluded NPV.
• Explain why the salvage value is added to the cash flows in the final year of the project.